The outgoing Governor of Reserve Bank of India Raghuram Rajan on Saturday said the status and the position of the central banker should not be changed in the interests of macroeconomic stability.
Delivering his last speech in his official capacity, Rajan also said central banking is not just increasing or reducing the interest rates but needs decisions – unpopular or hard-to-explain – to be made under conditions of extreme uncertainty.
Speaking on the Independence of the Central Bank at St.Stephens College here, Rajan also argued in favour of having an independent central banker and his role and responsibilities.
“There is a reason why Central Bank Governors sit at the table along with the Finance Ministers in G-20 meetings. It is that the Central Bank Governor, unlike other regulators or government secretaries, has command over significant policy levers and has to occasionally disagree with the most powerful people in the country,” Rajan said.
He said it is dangerous to have a de facto powerful position with low de jure status.
Rajan said the RBI Governor is appointed by the Prime Minister in consultation with the Finance Minister and his/her salary is of the Cabinet Secretary.
Though the RBI Governor’s rank in the government hierarchy is not defined but it is generally agreed that the decisions are explained only to the Prime Minister and the Finance Minister and the central banker has the room to make needed decisions.
“In the interests of macroeconomic stability, none of this should be changed, though if these issues are ever revisited, there may be some virtue in explicitly setting the Governor’s rank commensurate with her position as the most important technocrat in charge of economic policy in the country,” Rajan said.
“The Reserve Bank cannot just exist, its ability to say ‘No!’ has to be protected. At the same time, the central bank cannot become free of all constraints, it has to work under a framework set by the Government. This requires a number of actions,” Rajan said.
He said when the responsibilities of the RBI are fuzzy, its actions can continuously be questioned.
“Instead, if the constitutional authorities outline a framework for the responsibilities of the RBI, it can take actions consistent with those responsibilities and be held to outcomes. The inflation objectives recently set for the RBI by the Government are an example of what is needed,” he said.
According to Rajan, critics can lambast the RBI if it fails continuously to meet the objectives, but if they want it to lower interest rates even when the RBI barely meets its objectives, they should instead petition the Government to change the objectives.
“Similarly, the RBI Board has adopted a risk management framework which indicates the level of equity the RBI needs, given the risks it faces. The dividend policy of the RBI then becomes a technical matter of how much residual surplus is available each year after bolstering equity. Frameworks thus reduce the space for differences,” he said.
Pointing out RBI’s role in macroeconomic stability being fuzzy, Rajan said while RBI clearly has responsibility for the safety and soundness of credit institutions and the stability of the external account, there are some areas that are hazier.
“For example, with an inflation focused framework, the RBI’s ability to be accommodative depends on fiscal prudence from the Centre and states. How much should the RBI warn on fiscal profligacy, including the building up of contingent liabilities, and when should such warning be seen as interfering in the legitimate decisions of the elected representatives of the people? This is an area where clarity would be useful,” Rajan said.
Stressing on the importance of RBI Governors communicating on the rationale for policies and decisions, Rajan said: “Public understanding can help ease the way for reforms, as well as increase support for policies. The RBI Governor therefore has to explain again and again.”
“Occasionally, of course, the Governor has to warn about the dangers of certain courses of action or certain tendencies in the economy for growth and macroeconomic stability. Finally, the Governor is also a role model for the youth in this country, and should therefore not duck the responsibility to urge them to follow the highest standards of citizenship when he or she is invited to speak directly to them,” he remarked.